Buying Merger Targets: It's `A Dangerous Game'

Nothing makes the adrenaline pump like watching a stock shoot up 25% in one day. So, when Manufacturers Hanover Corp. jumped 26% and Chemical Banking Corp. 16% after their July 15 merger announcement, investors felt the temptation to find other banks about to do the same--and buy in beforehand.

Bank stocks rose 5% in a day on such excitement (chart). Yet professionals warn investors not to wrack their brains wondering which bank will be next. "To make merger potential your No. 1 criterion is a dangerous game," says George M. Salem, a Prudential Securities Inc. analyst. Despite guessing games played by Wall Streeters, analysts say there's no way of spotting the marrying kind with much certainty. And if you're wrong, you could be stuck with a Bank of New England Corp. in your portfolio.

HEALTHY GLOW. Instead, think fundamentals. Money managers say the smart picks now are banks with strong deposit bases, high ratios of equity to assets, and profitable lending lines. Such banks should do well in any climate. And in an era of consolidation, they're in a good spot to snap up smaller banks--or be snapped up themselves. Examples on the list of Karen L. Finkel, portfolio manager of PaineWebber Inc.'s Regional Financial Growth Fund, include Keycorp in Albany, N. Y., which has low costs and a winning strategy of focusing on markets where it can dominate, and Chicago's Northern Trust Corp., which boasts a fee-based trust operation with little credit risk.

A favorite is Banc One Corp. in Columbus, Ohio, which has succeeded by focusing on retail lending and credit cards and by acquiring dozens of smaller banks. Shelby Davis, who manages the $400 million New York Venture Fund Inc., is a Banc One bull. "I prefer companies doing the acquiring," he says. "You can only be acquired once. Companies doing the acquiring can do it again and again."

Investors may also thrive by keeping money on potential intramarket mergers--those, as with Manufacturers and Chemical, that stand to slash overhead. One such possibility is the merger being mulled between Cleveland's National City Corp. and Ameritrust Corp.

For adventurers, patience is key. Davis says he's sticking to high- and medium-grade banks for now, including Banc One and Wachovia Corp. in Winston-Salem, N. C., in the first category and First Bank System Inc. in Minneapolis in the second.

But if the recovery takes hold, Davis will get ready to reachfor more speculative plays. "As the future gets clearer in terms of nonperforming loans peaking, you might trade down from the highest quality to medium grade and eventually to the most troubled, some of which might turn around," he says. But remember: The weaker a bank's balance sheet, the higher investors' risk.

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